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IFMP Financial Analysts Certification Level 1, Pakistan study materials
IFMP Financial Analysts Certification Level 1, Pakistan study resources

IFMP Financial Analysts Certification Level 1, Pakistan practice questions

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Question 1Financial Analysts Level 1

Under the Pakistan regulatory framework for listed companies, which body is primarily responsible for approving the listing of securities on a stock exchange and overseeing market intermediaries?

  1. The Pakistan Institute of Corporate Governance (PICG)
  2. The Federal Board of Revenue (FBR)
  3. The Securities and Exchange Commission of Pakistan (SECP) Correct answer.
  4. The State Bank of Pakistan (SBP)

Explanation

The SECP is the apex regulator of Pakistan's capital markets and corporate sector, and it administers the Securities Act and the listing regulations under which exchanges and intermediaries operate. The SBP regulates banking and monetary policy, while the FBR handles taxation and the PICG is a governance institute rather than a securities regulator.

Question 2Financial Analysts Level 1

A financial analyst in Pakistan wants the risk-free rate for a rupee-denominated valuation. Which instrument is the most standard proxy for this rate?

  1. KIBOR on a three-month tenor
  2. Six-month Treasury bill yield Correct answer.
  3. The SBP policy (reverse repo) rate
  4. The KSE-100 dividend yield

Explanation

Short-dated government paper such as the six-month Treasury bill is treated as default-free in local currency and is the conventional proxy for the risk-free rate. KIBOR is an interbank lending rate that embeds bank credit and liquidity spreads, the dividend yield is an equity return measure, and the policy rate is a monetary tool rather than a traded yield.

Question 3Financial Analysts Level 1

A company reports net income of PKR 240 million, preference dividends of PKR 40 million, and 50 million weighted average ordinary shares. What is basic earnings per share?

  1. PKR 3.20
  2. PKR 4.80
  3. PKR 4.00 Correct answer.
  4. PKR 5.60

Explanation

Basic EPS deducts preference dividends from net income before dividing by the weighted average number of ordinary shares: (240 − 40) ÷ 50 = PKR 4.00. Ignoring the preference dividend overstates EPS, and adding it would be incorrect because preference holders rank ahead of ordinary shareholders.

Question 4Financial Analysts Level 1

In a discounted cash flow valuation, an analyst increases the assumed terminal growth rate while holding all other inputs constant. What is the effect on the estimated value?

  1. The value is unchanged because terminal growth only affects cash flows beyond the forecast horizon
  2. The value falls because higher growth raises the discount rate
  3. The value falls because higher growth reduces the present value of each future cash flow
  4. The value rises because the terminal value grows and is discounted at the same rate Correct answer.

Explanation

Terminal value under the Gordon growth model equals the final-year cash flow times (1 + g) divided by (WACC − g). Raising g increases the numerator and shrinks the denominator, so terminal value and hence total value rise, assuming WACC is held fixed.

Question 5Financial Analysts Level 1

Which statement best describes the relationship between bond prices and market yields for a fixed-coupon bond?

  1. Prices move inversely to yields, with greater sensitivity for longer maturities Correct answer.
  2. Prices are unaffected by yield changes once the bond is issued
  3. Prices move inversely to yields, with greater sensitivity for shorter maturities
  4. Prices move directly with yields because coupons are reinvested at higher rates

Explanation

A bond's price is the present value of its cash flows, so a higher discount rate lowers that present value. Longer-dated cash flows are discounted more heavily, making long-maturity bonds more price-sensitive to a given yield change.

Question 6Financial Analysts Level 1

A stock has a beta of 1.4, the risk-free rate is 9%, and the expected market return is 15%. Using the CAPM, what is the required return on equity?

  1. 15.0%
  2. 21.0%
  3. 12.6%
  4. 17.4% Correct answer.

Explanation

CAPM gives required return = risk-free rate + beta × (market return − risk-free rate) = 9% + 1.4 × 6% = 17.4%. The equity risk premium of 6% is scaled by beta before being added to the risk-free rate.

Question 7Financial Analysts Level 1

Which of the following is classified as an investing activity in a statement of cash flows prepared under IAS 7?

  1. Proceeds from a short-term bank overdraft
  2. Payment of dividends to shareholders
  3. Purchase of property, plant and equipment for cash Correct answer.
  4. Interest paid on long-term borrowings

Explanation

Acquiring property, plant and equipment is the acquisition of a long-term asset and is reported as an investing cash outflow. Dividends and interest paid, and overdraft proceeds, are financing or operating items depending on the accounting policy chosen under IAS 7.

Question 8Financial Analysts Level 1

An analyst notes that a company's current ratio is 2.0 and its quick ratio is 0.8. Which conclusion is most consistent with these figures?

  1. Short-term liquidity is strong because the current ratio exceeds 1
  2. A large portion of current assets is held in inventory Correct answer.
  3. The company has no short-term debt
  4. The company has excessive cash relative to its liabilities

Explanation

The gap between the current ratio and the quick ratio is driven by inventory, which is excluded from the quick ratio. A current ratio of 2.0 alongside a quick ratio of 0.8 implies inventory makes up a substantial share of current assets, which weakens immediate liquidity.

Question 9Financial Analysts Level 1

A firm issues a bond with a face value of PKR 1,000, a 10% annual coupon, and five years to maturity. If the market yield is 12%, the bond will trade:

  1. At a discount, because the coupon is below the market yield Correct answer.
  2. At a premium, because the coupon is fixed
  3. At par, because the coupon equals the face value rate
  4. At a discount only in the final year before maturity

Explanation

When the coupon rate is below the yield investors require, the fixed cash flows are worth less than face value, so the bond trades at a discount. The discount narrows over time and disappears at maturity as price converges to par.

Question 10Financial Analysts Level 1

A portfolio holds 60% in Stock A with an expected return of 12% and 40% in Stock B with an expected return of 7%. What is the portfolio's expected return?

  1. 9.5%
  2. 11.0%
  3. 8.4%
  4. 10.0% Correct answer.

Explanation

Portfolio expected return is the weighted average of component returns: 0.60 × 12% + 0.40 × 7% = 7.2% + 2.8% = 10.0%. Weights must sum to one and are applied directly to each asset's expected return.

Question 11Financial Analysts Level 1

A company's shares trade at PKR 80, the most recent dividend is PKR 4 per share, and dividends are expected to grow at 6% indefinitely. Using the Gordon growth model, what is the cost of equity?

  1. 11.0%
  2. 11.3% Correct answer.
  3. 10.6%
  4. 5.3%

Explanation

The Gordon growth model gives cost of equity = D1/P0 + g, where D1 = 4 × 1.06 = 4.24. Then 4.24 ÷ 80 + 0.06 = 0.053 + 0.06 = 11.3%. Using the current dividend instead of D1 understates the result.

Question 12Financial Analysts Level 1

Which of the following best explains why a company's operating cash flow can be positive while its net income is negative?

  1. Operating cash flow excludes all revenue recognized on credit
  2. Net income includes taxes while operating cash flow does not
  3. Operating cash flow is measured over a longer period than net income
  4. Non-cash charges such as depreciation are added back and working capital may be released Correct answer.

Explanation

Operating cash flow starts from net income and adds back non-cash expenses such as depreciation and amortization, then adjusts for working capital movements. A large depreciation charge or a release of working capital can therefore push cash flow above a negative accounting profit.

Question 13Financial Analysts Level 1

In Pakistan, trading on the Pakistan Stock Exchange is conducted through which mechanism for the cash-ready market?

  1. An auction held once each quarter
  2. A dealer market where only brokers quote prices
  3. A bilateral negotiation floor with no central counterparty
  4. A centralised electronic order-driven trading system Correct answer.

Explanation

The PSX operates an automated, screen-based order-driven system in which buy and sell orders are matched by price and time priority, with clearing and settlement handled by a central depository and clearing company. Trading is continuous rather than periodic or purely bilateral.

Question 14Financial Analysts Level 1

A firm has debt of PKR 400 million and equity of PKR 600 million. The after-tax cost of debt is 7% and the cost of equity is 15%. What is the weighted average cost of capital?

  1. 12.2%
  2. 13.5%
  3. 11.8% Correct answer.
  4. 11.0%

Explanation

WACC uses market-value weights: debt weight 0.40 and equity weight 0.60. Then 0.40 × 7% + 0.60 × 15% = 2.8% + 9.0% = 11.8%. Using book weights or pre-tax debt cost would change the answer.

Question 15Financial Analysts Level 1

Which of the following is the most direct consequence of a central bank raising its policy rate in Pakistan?

  1. Equity valuations are unaffected because discount rates are unchanged
  2. Government bond prices rise immediately on the announcement
  3. Short-term market interest rates tend to rise, increasing borrowing costs Correct answer.
  4. The rupee is guaranteed to depreciate against all currencies

Explanation

A policy rate increase is transmitted through the money market, pushing up short-term interbank and lending rates and raising the cost of borrowing. Higher discount rates typically pressure asset prices rather than lift them, and currency effects are not guaranteed.

Question 16Financial Analysts Level 1

A company reports a gross profit margin of 35% and a net profit margin of 8%. Which factor most plausibly explains the difference?

  1. High operating expenses and financing costs relative to sales Correct answer.
  2. An increase in the gross profit margin over the prior period
  3. A decline in the cost of goods sold as a percentage of sales
  4. A reduction in the number of shares outstanding

Explanation

Gross margin reflects only cost of goods sold, while net margin deducts operating expenses, interest, and taxes. A large gap between the two therefore points to heavy operating and financing costs eating into gross profit.

Question 17Financial Analysts Level 1

An investor buys a stock at PKR 50 and sells it one year later at PKR 56 after receiving a dividend of PKR 3. What is the total holding-period return?

  1. 18% Correct answer.
  2. 12%
  3. 15%
  4. 6%

Explanation

Holding-period return combines capital appreciation and income: (56 − 50 + 3) ÷ 50 = 9 ÷ 50 = 18%. Ignoring the dividend gives only the price return of 12%.

Question 18Financial Analysts Level 1

Which of the following best describes the purpose of a company's statement of changes in equity?

  1. To present the cash generated from operating activities
  2. To list the market prices of the company's shares during the year
  3. To disclose the fair value of all financial instruments held
  4. To reconcile opening and closing equity by showing movements such as profit, dividends and other comprehensive income Correct answer.

Explanation

The statement of changes in equity links the opening and closing balances of each equity component, showing total comprehensive income, transactions with owners such as dividends and share issues, and other movements. Fair value disclosures and cash flows appear in other statements and notes.

Question 19Financial Analysts Level 1

A stock's returns have a standard deviation of 20% and a beta of 1.2. If the market's standard deviation is 16%, what is the correlation between the stock and the market?

  1. 1.20
  2. 0.96 Correct answer.
  3. 0.80
  4. 0.75

Explanation

Beta equals correlation × (stock standard deviation ÷ market standard deviation). Rearranging, correlation = beta × market standard deviation ÷ stock standard deviation = 1.2 × 16 ÷ 20 = 0.96. A correlation near one indicates the stock moves closely with the market.

Question 20Financial Analysts Level 1

A company has an operating profit of PKR 500 million, interest expense of PKR 100 million, and a tax rate of 30%. What is its net income?

  1. PKR 400 million
  2. PKR 350 million
  3. PKR 280 million Correct answer.
  4. PKR 300 million

Explanation

Profit before tax is 500 − 100 = 400 million, and after tax at 30% the net income is 400 × 0.70 = 280 million. Applying tax to operating profit before interest would overstate the tax base and understate net income.

Question 21Financial Analysts Level 1

An analyst observes that a firm's return on equity is 18% while its return on assets is 9%. Which conclusion is most defensible?

  1. The firm has an unusually high asset turnover relative to peers
  2. The firm uses significant financial leverage, which magnifies returns to equity holders Correct answer.
  3. The firm's net profit margin must exceed its gross profit margin
  4. The firm holds no interest-bearing debt

Explanation

The gap between ROE and ROA is explained by the equity multiplier: ROE = ROA × (assets ÷ equity). An ROE roughly double the ROA implies assets are about twice equity, indicating substantial debt financing and amplified returns and risk.

Question 22Financial Analysts Level 1

A portfolio is equally split between two assets, each with a standard deviation of 15%. If the correlation between them is −1, what is the portfolio standard deviation?

  1. 15%
  2. 0% Correct answer.
  3. 30%
  4. 7.5%

Explanation

With perfect negative correlation and equal weights, the portfolio variance is (0.5 × 15% − 0.5 × 15%)² = 0. The two assets' movements offset exactly, eliminating risk entirely in this special case.

Question 23Financial Analysts Level 1

A firm's inventory turnover falls from 8 to 5 while sales remain constant. Which interpretation is most appropriate?

  1. The firm has improved its ability to convert inventory into sales
  2. Average inventory has risen, tying up working capital and suggesting slower stock movement Correct answer.
  3. Cost of goods sold has increased proportionally with inventory
  4. The firm's receivables collection period has shortened

Explanation

Inventory turnover equals cost of goods sold divided by average inventory. With sales constant, a lower turnover implies higher average inventory, indicating slower movement and more capital tied up in stock, which is a liquidity concern.

Question 24Financial Analysts Level 1

Which of the following securities offers the holder a claim on residual earnings after all other obligations are settled?

  1. Preference shares
  2. Commercial paper
  3. Ordinary shares Correct answer.
  4. Secured corporate bonds

Explanation

Ordinary shareholders are residual claimants: they receive what remains after creditors, bondholders and preference shareholders are paid. Preference shares and debt carry priority claims with defined payments ahead of ordinary equity.

Question 25Financial Analysts Level 1

An analyst applies a price-to-earnings multiple of 12 to expected earnings per share of PKR 9. What is the implied value per share?

  1. PKR 108 Correct answer.
  2. PKR 96
  3. PKR 75
  4. PKR 21

Explanation

The P/E multiple is applied multiplicatively to earnings per share: 12 × 9 = PKR 108. Adding the two figures instead of multiplying them is a common error and gives an incorrect result.

Question 26Financial Analysts Level 1

Under IFRS as applied in Pakistan, which financial statement reports an entity's assets, liabilities and equity at a specific point in time rather than over a period?

  1. Statement of financial position Correct answer.
  2. Statement of profit or loss
  3. Statement of cash flows
  4. Statement of comprehensive income

Explanation

The statement of financial position (balance sheet) presents assets, liabilities and equity as a snapshot at the reporting date, whereas the other statements cover a period of performance or flows. This distinction is fundamental to reading published accounts of PSX-listed companies.

Question 27Financial Analysts Level 1

A company's shares are quoted at PKR 45 and it has 20 million shares outstanding. What is its market capitalisation?

  1. PKR 90 million
  2. PKR 900 million Correct answer.
  3. PKR 2,250 million
  4. PKR 450 million

Explanation

Market capitalisation equals share price multiplied by shares outstanding: 45 × 20 million = PKR 900 million. It measures the equity market value of the firm and is widely quoted for PSX-listed companies.

Question 28Financial Analysts Level 1

Which of the following best describes the role of the Securities and Exchange Commission of Pakistan (SECP) in the capital markets?

  1. It sets the country's monetary policy and policy interest rate
  2. It guarantees investors against losses on listed securities
  3. It manages the government's fiscal budget and taxation
  4. It regulates corporate conduct and securities markets and protects investors Correct answer.

Explanation

The SECP is the apex regulator for corporate and securities markets in Pakistan, with a mandate covering investor protection and market integrity. Monetary policy sits with the State Bank of Pakistan, and no regulator guarantees investment returns.

Question 29Financial Analysts Level 1

An analyst wants a measure of a company's ability to meet short-term obligations using only its most liquid current assets. Which ratio should be used?

  1. Current ratio
  2. Gross profit margin
  3. Debt-to-equity ratio
  4. Quick ratio Correct answer.

Explanation

The quick (acid-test) ratio excludes inventory from current assets, focusing on cash, receivables and short-term investments. The current ratio includes inventory and is therefore less stringent.

Question 30Financial Analysts Level 1

A bond is issued at a price below its face value. How is this bond described?

  1. Issued with a zero coupon
  2. Issued at a premium
  3. Issued at par
  4. Issued at a discount Correct answer.

Explanation

When the issue price is below face value the bond is issued at a discount, meaning the yield to maturity exceeds the coupon rate. A premium arises when the price exceeds face value, and par means price equals face value.

Question 31Financial Analysts Level 1

Which of the following is a primary market transaction?

  1. A broker transferring shares between two client accounts
  2. An investor subscribing to shares in a company's initial public offering Correct answer.
  3. An investor selling shares back to another retail investor
  4. An investor buying existing shares on the PSX from another investor

Explanation

A primary market transaction involves the issuer raising new capital directly from investors, as in an IPO. Secondary market trades merely transfer existing securities between investors without new funds reaching the issuer.

Question 32Financial Analysts Level 1

A company reports net income of PKR 200 million and pays preference dividends of PKR 20 million. It has 60 million ordinary shares outstanding. What is basic earnings per share?

  1. PKR 3.33
  2. PKR 0.33
  3. PKR 3.00 Correct answer.
  4. PKR 2.67

Explanation

Basic EPS equals net income less preference dividends divided by the weighted average number of ordinary shares: (200 − 20) / 60 = PKR 3.00. Preference dividends are deducted because they are not available to ordinary shareholders.

Question 33Financial Analysts Level 1

Which of the following best describes the time value of money concept?

  1. Future cash flows are always riskier than present cash flows
  2. Interest rates have no effect on the value of future cash flows
  3. A sum received today is worth more than the same sum received in the future Correct answer.
  4. Money loses value only when inflation is negative

Explanation

The time value of money holds that a rupee today can be invested to earn a return, so it is worth more than an identical rupee received later. This underpins discounting and all present-value calculations in valuation.

Question 34Financial Analysts Level 1

An analyst is forecasting free cash flow to the firm. Which item should be added back to after-tax operating profit in the calculation?

  1. Dividends paid to ordinary shareholders
  2. Repayment of long-term debt principal
  3. Depreciation and amortisation Correct answer.
  4. Interest expense

Explanation

Free cash flow to the firm starts from after-tax operating profit and adds back non-cash charges such as depreciation and amortisation, then deducts capital expenditure and working capital investment. Financing flows such as interest, dividends and debt repayment are excluded because FCFF is measured before financing.

Question 35Financial Analysts Level 1

A firm's sales are PKR 1,200 million, its total asset turnover is 1.5, and its net profit margin is 6%. Using the DuPont decomposition, what is its return on assets?

  1. 9.0% Correct answer.
  2. 4.0%
  3. 6.0%
  4. 12.0%

Explanation

Under the DuPont framework ROA equals net profit margin multiplied by total asset turnover: 6% × 1.5 = 9.0%. The sales figure is not needed once both components are given, but it confirms assets of PKR 800 million.

Question 36Financial Analysts Level 1

An analyst expects a company to pay a dividend of PKR 6 next year, with dividends growing at 4% thereafter, and requires a return of 13%. Using the Gordon growth model, what is the intrinsic value per share?

  1. PKR 66.67 Correct answer.
  2. PKR 60.00
  3. PKR 150.00
  4. PKR 46.15

Explanation

The Gordon growth model values the share as D1 divided by (r − g): 6 / (0.13 − 0.04) = 6 / 0.09 = PKR 66.67. The model requires the required return to exceed the growth rate for a finite, positive value.

Question 37Financial Analysts Level 1

A company has an order backlog that grew sharply, but its reported revenue was flat and receivables days rose from 45 to 75. Which interpretation is most consistent with these observations?

  1. The company has improved its cash collection efficiency
  2. Revenue recognition may be delayed or collections weakened, warranting scrutiny of cash conversion Correct answer.
  3. The order backlog guarantees higher revenue next quarter
  4. Flat revenue with rising receivables indicates strong pricing power

Explanation

Rising receivable days alongside flat revenue suggests cash is being tied up in unpaid invoices, which may reflect weaker collections or aggressive revenue timing. An analyst should examine the cash conversion cycle and revenue recognition policies before extrapolating the backlog into future earnings.

Question 38Financial Analysts Level 1

A bond with a modified duration of 5 and a yield to maturity of 10% experiences a 50 basis point increase in yield. What is the approximate percentage change in price?

  1. −5.0%
  2. +2.5%
  3. −0.25%
  4. −2.5% Correct answer.

Explanation

The approximate price change equals minus modified duration multiplied by the change in yield: −5 × 0.005 = −0.025, or −2.5%. Prices move inversely to yields, and duration measures the sensitivity.

Question 39Financial Analysts Level 1

An analyst calculates a company's interest coverage ratio as 2.5 times and notes that its EBITDA is highly cyclical. Which conclusion is most appropriate?

  1. The ratio confirms strong liquidity because cash exceeds current liabilities
  2. The firm's profitability is stable across the business cycle
  3. The firm has limited headroom to absorb an earnings downturn before interest cover becomes strained Correct answer.
  4. The firm is conservatively financed and faces minimal refinancing risk

Explanation

An interest coverage of 2.5 times means operating earnings could fall by 60% before covering interest, leaving modest headroom. Combined with cyclical EBITDA, this raises credit risk and warrants stress testing under a downside scenario.

Question 40Financial Analysts Level 1

Under the Capital Asset Pricing Model, which component represents the expected excess return of the market over the risk-free rate?

  1. Beta coefficient
  2. Risk-free rate
  3. Firm-specific risk premium
  4. Market risk premium Correct answer.

Explanation

The CAPM formula is expected return = risk-free rate + beta × market risk premium, where the market risk premium is the expected market return minus the risk-free rate. Beta scales this premium for the asset's systematic risk.

Question 41Financial Analysts Level 1

A company's statement of cash flows shows a large positive operating cash flow, negative investing cash flow and negative financing cash flow. Which pattern is most consistent with a mature, profitable business?

  1. Strong operations funding capital expenditure while returning cash to lenders and shareholders Correct answer.
  2. A distressed firm liquidating assets to survive
  3. A start-up raising capital to fund losses
  4. A firm borrowing heavily to finance working capital

Explanation

Positive operating cash flow combined with investing outflows for capital expenditure and financing outflows for debt repayment or dividends is typical of a mature, cash-generative company. This pattern indicates self-funding growth and shareholder returns.

Question 42Financial Analysts Level 1

An investor holds a bond priced at PKR 950 with a face value of PKR 1,000 and a 7% annual coupon. What is the current yield?

  1. 5.00%
  2. 10.53%
  3. 7.00%
  4. 7.37% Correct answer.

Explanation

Current yield equals the annual coupon divided by the market price: 70 / 950 = 7.37%. Because the bond trades at a discount, the current yield exceeds the coupon rate.

Question 43Financial Analysts Level 1

A portfolio contains two assets with equal weights, standard deviations of 20% and 10%, and a correlation of +1. What is the portfolio standard deviation?

  1. 30%
  2. 15% Correct answer.
  3. 10%
  4. 14.1%

Explanation

With perfect positive correlation, portfolio standard deviation is the weighted average of the component standard deviations: 0.5 × 20% + 0.5 × 10% = 15%. Diversification benefits vanish when correlation equals +1.

Question 44Financial Analysts Level 1

A company's return on equity is 20% but its return on invested capital is 12%, while its weighted average cost of capital is 14%. Which conclusion is most defensible?

  1. The firm is destroying economic value despite reporting a high return on equity Correct answer.
  2. The firm's leverage has no effect on the ROE figure
  3. The firm should increase leverage to raise ROIC
  4. The firm is creating economic value because ROE exceeds the cost of capital

Explanation

Economic value is created only when return on invested capital exceeds the weighted average cost of capital. Here ROIC of 12% is below WACC of 14%, so the firm destroys value even though leverage lifts ROE above the cost of capital.

Question 45Financial Analysts Level 1

Which of the following best describes the effect of a share buyback financed with debt on a company's financial ratios?

  1. The buyback reduces total assets and has no effect on leverage
  2. Leverage rises and the share count falls, potentially increasing earnings per share Correct answer.
  3. Leverage falls and the share count falls, leaving earnings per share unchanged
  4. Leverage is unchanged and the share count rises

Explanation

Debt-financed buybacks reduce equity and increase debt, raising leverage ratios, while the lower share count can raise EPS if earnings do not fall proportionately. The EPS uplift is not automatic because interest expense on the new debt reduces net income.

Question 46Financial Analysts Level 1

An analyst values a company using a two-stage dividend discount model. Which assumption most critically affects the terminal value?

  1. The dividend paid in the first year of the forecast
  2. The company's historical share price volatility
  3. The perpetual growth rate used in the terminal stage Correct answer.
  4. The number of analysts covering the stock

Explanation

In a two-stage model the terminal value usually dominates total value, and it is highly sensitive to the perpetual growth rate because that rate sits in the denominator. A small change in the assumed growth rate can materially shift the valuation.

Question 47Financial Analysts Level 1

A company reports a deferred tax liability that has grown steadily for several years. Which interpretation is most appropriate?

  1. It confirms the company has no permanent differences in its tax position
  2. It reflects timing differences, often from accelerated tax depreciation, that may reverse in future periods Correct answer.
  3. It indicates the company has overpaid tax and expects a refund
  4. It represents a current cash tax obligation payable within twelve months

Explanation

A growing deferred tax liability typically arises from temporary differences such as accelerated capital allowances, where tax is deferred rather than avoided. Analysts should assess whether the liability is likely to reverse or remain indefinitely, since this affects the after-tax cash flow outlook.

Question 48Financial Analysts Level 1

Two companies report identical net income, but Company A capitalises development costs while Company B expenses them. Which analytical adjustment is most appropriate for comparability?

  1. Ignore the difference because both policies are permitted under IFRS
  2. Capitalise and amortise Company B's development spending to align policies before comparing profitability Correct answer.
  3. Compare the reported net income figures directly without adjustment
  4. Adjust Company A's revenue upward to match Company B

Explanation

Capitalising versus expensing development costs changes both profit and asset base, so comparability requires restating one company to the other's policy. Applying capitalisation and amortisation to Company B aligns the timing of expense recognition and the resulting ratios.

Question 49Financial Analysts Level 1

An analyst estimates a firm's sustainable growth rate as ROE multiplied by the retention ratio. If ROE is 15% and the dividend payout ratio is 40%, what is the sustainable growth rate?

  1. 6.0%
  2. 10.0%
  3. 9.0% Correct answer.
  4. 15.0%

Explanation

The retention ratio is 1 minus the payout ratio, or 60%. Sustainable growth equals ROE times the retention ratio: 15% × 0.60 = 9.0%, the rate the firm can grow without changing leverage.

Question 50Financial Analysts Level 1

A firm reports operating leases only as annual disclosures rather than on-balance-sheet debt. Under a capitalisation approach, which effect on the firm's leverage and coverage ratios is most likely?

  1. Leverage rises and interest coverage also rises
  2. Leverage rises and interest coverage falls once the lease obligation is recognised Correct answer.
  3. Leverage falls and interest coverage rises
  4. Both ratios remain unchanged because leases are operating expenses

Explanation

Capitalising operating leases adds a debt-like obligation and an implied interest charge, increasing the debt ratio and reducing the interest coverage ratio. This adjustment improves comparability with firms that finance assets through on-balance-sheet debt.